People can buy many things with their money, but they can’t make significant investments without getting a loan. For example, only 30% of Americans have purchased a home using only cash. That’s a decent percentage, but most Americans still rely on loans to buy a house.
There are many types of loans that people take for different purposes. But before anything else, let’s talk about the two main kinds of loans: conventional and government-based.
1. Government-Based Loans
As the name suggests, these loans are given by the government. As a result, they tend to have lower interest rates and downpayment options. The most popular government-based loans are FHA loans and VA loans. Both are meant for buying homes.
The government offers many outstanding loans, but nothing comes close to FHA loans. The Federal Housing Administration (FHA) loan is a loan that the government insures. If the borrower defaults on the loan, the government will pay back the lender. Because of this, lenders are more willing to give FHA loans to borrowers with less-than-perfect credit. The minimum credit score for an FHA loan is 580.
Veterans need a leg up to purchase a home. That’s why VA loans are available to veterans and their spouses. It has the same structure as FHA loans, but the main difference is that VA loans don’t require their clients to make a downpayment.
2. Conventional Loans
Financial institutions like banks give many loans. These are called conventional loans. Unlike government loans, the terms and conditions of a conventional loan are set by the lender. The interest rate, maturity date, and other features of the loan will depend on the bank’s policies. However, they are highly regulated and privatized. They also tend to have higher interest rates than government-based loans, because they’re designed to make a profit. But they offer a lot more money than government-based loans, which makes them great for those who want to start a business.
This article will primarily tackle conventional loans. First, however, here are some of the most common loans and how they can affect your finances.
Many Americans get a mortgage for their home or their investment. Conventional mortgages are a safe investment for anyone with a good credit score because they offer a fixed interest rate. As a result, your monthly payments will never increase, no matter how high inflation rates.
Mortgage loans are typically paid over 15 to 30 years. The longer you take to pay off the loan, the more interest you’ll have to pay. But if you can’t afford the monthly payments of a 15-year loan, you can always choose a more extended repayment period. Remember that the longer you pay off the loan, the more interest you’ll have to pay.
The main advantage of this kind of loan is that it gives you access to refinancing. Refinancing is when you get a new loan with better terms to replace your old one. So, for example, you can refinance your 30-year mortgage into a 15-year mortgage and save a lot of money in interest payments.
4. Auto Loan
Most Americans can purchase a car outright. However, those that can’t use an auto loan. The terms and conditions of an auto loan are similar to a mortgage. The main difference is that an auto loan is typically paid off in 5 years or less.
The main advantage of an auto loan is that it allows you to buy a car without paying the total price upfront. Because of the lower costs of vehicles, auto loans don’t severely hinder your finances from growing. But they are a stagnant and depreciating investment, which means that you’ll end up owing more money than the car is worth, and since you’ll still have to pay for the interest, you have a huge potential to lose money. So by the end of the day, it might be better to lease than to buy using an auto loan.
5. Student Loan
Not many people can afford the high costs of college tuition. This is why student loans are so popular. Student loans are probably the most common in the United States and uniquely affect people’s finances.
Unlike other loans, student loans can’t be discharged in bankruptcy. Unfortunately, you’ll have to pay back your student loan even if you can’t find a job after graduation.
The interest rates on student loans are also very high. The average interest rate for a student loan is around 8%. The government knows that many students will default on their loans. And since the government is the lender, they don’t care about making a profit.
The main advantage of a student loan is that it allows you to get an education. However, the high-interest rates and the fact that you can’t discharge the debt in bankruptcy make it a very risky investment.
While there are many different types of loans, the three we’ve discussed are some of the most common. Each loan has its unique set of advantages and disadvantages, which can affect your finances in various ways. It’s important to understand these before you take out any type of loan. Once you do, you can manage your finances more effectively and make better financial decisions.
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